Q&A: Peterson Institute’s Bergsten on China’s Currency

The widely quoted and influential director of the Peterson Institute for International Economics in Washington, Fred Bergsten has until recently been one of the most prominent critics of China’s policy of intervening in foreign exchange markets to weaken its currency. Now he thinks progress is finally being made to resolve this acrimonious dispute between the U.S. and China. In an article he wrote for the Institute’s website last week, he said that a “breakthrough” appeared to have been made because of a combination of Chinese inflation and the gradual appreciation in the yuan’s nominal exchange rate to the dollar since mid-2010, which is putting the inflation-adjusted exchange rate on track to achieve a needed correction of 20 to 30% over the next two to three years.
You recently wrote that the combination of inflation and gradual appreciation in the Chinese yuan’s exchange rate could be achieving a “breakthrough” in terms of U.S. demands for an increase in Chinese competitiveness. You said the increase in the inflation-adjusted real exchange rate was now in line with the trend that’s expected of China over the next two years. Can you explain?Bergsten: The real [inflation-adjusted] renmimbi exchange rate has appreciated against the dollar at an annual rate of about 12% since last June, although considerably less on a trade-weighted basis. The dollar has fallen against most other currencies, so on a trade-weighted basis, the renmimbi has risen less. On the other hand, one has to accept that the Chinese think of this totally in dollar terms. So the dollar exchange rate is a legitimate focus for them, and if you believe that the dollar is going to bounce around and come back over time it will drag the renmimbi back up with it [against those other currencies.]

They have been letting [the real exchange rate] go up an average of 10 to 12% on an annual basis so it’s fair to say that if they would let that continue for another couple of years they would achieve a restoration of underlying equilibrium in the exchange rate. That would take away most, if not all, of the distortions that their persistent interventions have created.

About four months ago, you estimated that the yuan was 30% undervalued, and many commentators read that as a strong critique of China’s exchange rate policy. Have the changes over past four months improved things enough for the U.S. to accept that the policy of deliberate undervaluation has changed?Bergsten: During its previous period of appreciation [between 2005 and 2008] the renmimbi went up 20 to 25% in a period of two and half years. I suggested recently that the goal should be the same amount this time and [Treasury Secretary Timothy] Geithner seemed to endorse this. I took that as a kind of wide agreement on what the outcome should be.

You’re talking about real exchange rate adjustments in which inflation plays a key role. Surely it would be China’s and other countries’ interests to have this adjustment take place through the nominal exchange rate and avoid the disruptions that inflation could cause in the world’s second biggest economy?Bergsten: Yes, especially given China’s history of hyperinflation, it would be far better to adjust via the nominal rate. It has always surprised me that they seem to prefer to do part of it through inflation. And now that they are really worried about inflation, which has become the focal point of their economic policy, this would be the perfect time for them to let the currency adjust. They know the currency is going to adjust over time anyway and it is better to let it happen through the nominal rate. At the same time, it’s an ideal time for us if they make the move now because it will help rebalance our external accounts and help deal with our high unemployment. From the standpoint of both sides there couldn’t be a better time to adjust the nominal exchange rate for the renmimbi.

Surely other countries aren’t happy about China basing its appreciation policy solely on the dollar exchange rate when the dollar itself is falling sharply against other currencies, especially emerging market currencies.Bergsten: One of the reasons the Chinese are moving now is because they have gotten a pretty wide array of complaints from other emerging markets — from Brazil, from India, from Mexico and others. They have been quite pointed in their criticism. Most of them have respected China’s desire not to be criticized publicly, so they do it privately. I’ve been in on some of those discussions, recently at Davos, for example. There is a lot of pressure on the Chinese from other emerging market countries.